Harnischfeger Harvard Case Study

1. Read the footnotes carefully. Identify four accounting policy changes and accounting estimates that Harnischfeger made during 1984 and estimate as accurately as possible the effect of these changes on the company's 1984 reported profits?

* In November 1983, the company included in net sales a more accurate portrayal of products purchased from Kobe Steel, Ltd. and sold by the corporation. Instead of including only the gross margin, the sales were recognized as $28 million. This had minimal effect on net income.

* In November 1983, the financial statements of foreign subsidiaries were included on the basis of their fiscal years ended July 31st. This change increased net sales by $5.4 million. This had minimal effect on net income.

* In 1984, the company changed depreciation methods on plants, machinery, and equipment from accelerated methods to the straight line method. This decision resulted in an increase in net income of $11 million or per share of $0.93. This change accounted for 72% of net income. Asset life was also changed on some PP&E and this resulted in an increase in net income of $3.2 million or per share of $0.27. These changes were made in order to conform to industry standards.

* In 1984, The Salaried Employees' Retirement Plan, which covers substantially all salaried employees in the U.S., was restructured due to overfunding of the Plan. This reduced pension expense by approximately $4 million and the actuarial present value of the accumulated plan benefits by approximately $60 million.

2. What do you think are the motives of Harnischfeger's management in making the changes in its financial reporting policies?

Harnischfeger had been reporting losses for the past three years and were moving into their centennial year. This was the time that they needed to restore confidence in investors and move forward with improving business strategies. Most of the changes had minimal effect on income except for the change in depreciation method which raised reportable net income by 72%. It appears that the main reason for making changes to their financial reporting policies was so that they would be able to report profits in their centennial year, but the depreciation method change was also made to stay aligned with competition. During this time competition was increasing so it would make sense to account for assets using industry standards. Overall I think that their intentions were good and they used this strategy in order to rededicate themselves through market leadership, customer service, and improved operating performance and profitability.

3. The efficient market hypothesis maintains that the stock market and stock prices react efficiently to publicly available information about a firm. In other words, market participants react intelligently and quickly to publicly available information and rapidly re-price stocks. One implication of an efficient capital market is that financial statement analysts can't find "undervalued" or "overvalued" securities. Another implication is that the market will "see through" cosmetic accounting changes as long as they are publicly disclosed in the footnotes. Do you believe investors in Harnischfeger will "see through" the company's accounting changes?